‘Tis the season for scary movies, and I’ve seen enough of them to know I don’t like them! One in particular that I’ve seen is George Romero’s 1968 movie, Night of the Living Dead. In it, hundreds of zombies descend on a Pennsylvania farmhouse (I’m from Pennsylvania…), where a terrified group of very-much alive people band together to fend them off. The zombies are a groaning, mindless mob, and in some ways, the humans inside the farmhouse become mindless as well, succumbing to fear and falling victim to each other, as well as to the zombies.
Q3 2020 hedge fund letters, conferences and more
When things get scary, it’s easy to stop thinking rationally and simply follow the will of the crowd. I’m reminded of a TV commercial for an insurance company, in which a group of teenagers are trying to escape from a horror-film character. As the group tries to hatch an escape plan, one suggests, “Let’s hide in the attic!” Another suggests the basement, and a third pleads, “Why can’t we just get into the running car?” Ultimately, the group agrees to hide behind the chainsaws in the shed (exactly where the boogie man is hiding) as the announcer says, “When you’re in a horror movie, you make poor decisions. It’s what you do.”
Emotions, like fear or even exuberance, can lead to something called “herd mentality.” Research by Raafat, Chater and Frith describes herding as “the alignment of thoughts or behaviours of individuals in a group (herd) through local interactions rather than centralized coordination.” In other words, when in doubt, follow the crowd and hope for the best ¬¬— even if the crowd doesn’t know what it’s doing!
Herd Mentality: Following the Investing Crowd
In my practice as a financial adviser, I see examples of herd mentality almost daily. Most recently, as the coronavirus caused markets to freefall in March, clients whose family members or friends wanted to pull everything out of the market told me they also wanted to move to cash. Often, news headlines or social media chatter also played a role in their desire to change strategies, as opposed to research or a change in goals. One client who refused to allow our firm to invest his cash lost the opportunity to earn a significant amount of money when the market recovered, because he insisted upon waiting for the market to stabilize; another insisted on changing his investment strategy, moving from higher equity exposure to a much lower equity exposure, pulling out of equity at exactly the wrong time.
The dotcom bubble of the late 1990s and early 2000s is another example of herd mentality, and while fear played a role in investors’ decision-making in this situation, it was “fear of missing out” (FOMO), rather than fear of losing money. During that period, entrepreneurs started tech businesses right and left — often without a product, customers, or even a solid understanding of the market opportunity. Venture capital money was plentiful, and exuberant investors wanted to be a part of the new “new thing.”
Remember Pets.com, the online pet supply store with the popular sock-puppet spokesman? Investors flocked to its’ stock and the sudden rise and fall was indicative of the many internet start-ups that sunk big money into marketing budgets instead of solving the problems created by their business models. Despite its popularity, and its inflated stock price, the Pets.com story began and ended in just 27 months. Ironically, the sock puppet had a longer career; it went on to become the spokespuppet for 1-800-Bar None after Pets.com failed.
In both the coronavirus and the dotcom bubble examples, investors felt comfortable following the crowd without doing their homework. As James Montier wrote in “The Little Book of Behavioral Investing,” numerous experiments have shown that people have a tendency to conform to group think when seeing as few as three others doing so. When researchers used an MRI to understand conformity within a group, they found that when people went with the group answer, they seemed to show a decrease in activity of the parts of the brain associated with logical thinking. At the same time, they found that the amygdala — which deals with emotional processing and fear — lit up in their test subjects.
Avoiding Herd Mentality
The next time you face a situation in which you feel pressure to follow the crowd — whether it’s a decision involving fashion, food, politics or investing, I invite you to try becoming a contrarian instead of adopting the “wisdom” of the crowd. According to Montier, taking on the role of contrarian involves three key elements:
- Courage. As Montier writes, being a non-conformist can cause fear and pain. Nonconformists can face social rejection when they break from what the crowd expects. You can see examples of this in politics every day!
- Critical thinking. Instead of simply following one-sided arguments that promote or criticize an issue, seek multiple points of view to get a more thorough understanding. Try taking a position and arguing against yourself, or making a list of pros and cons based on your own research. You may learn new information you hadn’t considered or see the situation in a new way.
- Perseverance and grit. This is particularly useful in the investment world. If you work with a financial adviser, you should have already identified your investment goals, strategy and risk tolerance. In volatile markets, these should form the bedrock of your decision making, not news headlines or the advice of your cousin.
I would add one more element to this list: asking whether it’s necessary to take action at all. When the markets took a nosedive earlier this year over the coronavirus threat, many of my clients felt compelled to take action -- because they thought they should “do something.” In times of high anxiety, doing nothing can also be an effective strategy. It may keep you from making decisions you’ll regret when things calm down.
Whether it’s a zombie apocalypse, a deadly virus, or simply excitement over the newest iPhone, we can make the choice to be thoughtful in our response. You may not win a popularity contest, but you’ll likely feel better about your decision.
